Abstract

Funds investing in illiquid assets report returns with spurious autocorrelation. Consequently,
investors need to unsmooth these funds’ returns when evaluating their risk
exposures. We show that funds with similar investments share a common source of
spurious autocorrelation not fully resolved by traditional unsmoothing methods and thereby
leading to underestimation of systematic risk. Thus, we propose a generalized unsmoothing
technique and apply it to hedge funds and private commercial real estate funds. Our
method significantly improves the measurement of funds’ risk exposures and risk-adjusted
performance, especially for highly illiquid funds. Overall, the average illiquid fund alpha
is lower than previously thought.

Authors

Spencer J. Couts, University of Southern California
Andrei S. Gonçalves, The Ohio State University
Andrea Rossi, University of Arizona